Inheritance Tax Annuity Calculator: Estate, Income, and IRD

An inherited annuity usually triggers ordinary income tax on the payments you receive, and in rare cases federal estate tax on the contract’s value as well. For 2026, the federal estate tax exemption is $15 million per person, so most estates owe nothing at that level.¹ The income tax on inherited annuity distributions, though, hits almost every beneficiary. How much you owe depends on what kind of annuity it is, how you take the money, and your relationship to the person who died.

Income Tax on the Payments You Receive

This is the tax nearly every beneficiary actually pays. Annuity payments to a beneficiary are treated as income in respect of a decedent, which means they are taxed the same way they would have been taxed had the original owner lived to receive them.² Whether the whole payment is taxable or only part of it comes down to how the annuity was funded.

Qualified Annuities

A qualified annuity is one held inside a tax-advantaged retirement account such as an IRA or 401(k). The original contributions went in pre-tax, so every dollar coming out is taxable as ordinary income. There is no tax-free return of principal. Required minimum distribution rules also apply, which control how quickly you have to withdraw the money.

Non-Qualified Annuities

A non-qualified annuity was bought with money that had already been taxed. Only the earnings portion of each payment is taxable; the return of principal is not. The IRS uses an exclusion ratio to divide each periodic payment between the tax-free basis and the taxable earnings.

Lump Sum Versus Periodic Payments

How you take the money changes the size of the tax bill even when the total amount is the same. A lump sum concentrates all the taxable income into one year and can push you into a higher bracket. Periodic payments stretch the liability across several years. If the original owner died before payments began and you take the death benefit as a lump sum, everything above the owner’s cost basis is fully taxable in the year received.²

The Surviving Spouse Option

A surviving spouse named as sole beneficiary generally has a choice no one else gets: continuing the contract as the new owner instead of taking a distribution. Nothing is taxable until the spouse begins withdrawals, which can defer the tax for years.

When Federal Estate Tax Also Applies

The One Big Beautiful Bill, signed on July 4, 2025, set the basic exclusion amount at $15 million per person for 2026, with inflation adjustments starting in 2027.¹ A married couple using portability can shelter up to $30 million. Only the value above the exemption is taxed, on a graduated schedule that runs from 18% on the first $10,000 over the threshold to 40% on amounts more than $1 million over it.³

For an estate of $3 million that includes a $400,000 annuity, no federal estate tax is owed and no return is required. The beneficiary still owes income tax on the payments.

How Much of the Annuity Counts

The IRS treats annuity contracts as includible assets in a decedent’s gross estate.⁴ If the deceased was receiving payments, or had the right to receive them, and a beneficiary starts receiving payments because the owner died, the contract’s value goes into the estate.⁵

The amount included is proportional to what the decedent contributed toward the purchase price. If your parent bought the annuity entirely with their own money, 100% of the value is in the estate. Employer contributions through a pension or retirement plan are still treated as the decedent’s contributions for this purpose, so most individually owned retirement annuities are fully includible.⁵

Valuing the Contract at Date of Death

If the owner died before payments began, the value is generally the account balance or the death benefit the insurance company will pay, whichever applies under the contract. No discounting is needed because there is no future stream to value yet.

If payments had already started, you calculate the present value of the remaining stream. The IRS requires the Section 7520 interest rate for the month of death, which is 120% of the federal midterm rate rounded to the nearest two-tenths of a percent. For April 2026, that rate is 4.6%.⁶ The rate feeds into actuarial tables the IRS publishes; Publication 1457 contains the factors and worked examples.⁷ You multiply the annual payment by the applicable factor to reach a present value. Younger beneficiaries produce higher factors because payments are expected to run longer; higher Section 7520 rates produce lower factors because future dollars discount more steeply.

The contract type controls which table applies. A life annuity pays until the recipient dies, so valuation depends on the beneficiary’s age. A term certain annuity pays for a fixed number of years regardless of survival, so life expectancy is irrelevant and only the remaining term matters. Separate tables exist for each.⁷

The IRD Deduction: Relief When Both Taxes Apply

When an inherited annuity is hit with estate tax and income tax on the same dollars, the law softens the overlap. A beneficiary who reports income tax on inherited annuity payments can claim an itemized deduction for the portion of federal estate tax attributable to the annuity’s inclusion in the estate.⁸ The deduction goes on the return for the same year the income is reported.

The calculation is not simple. You determine the estate tax attributable to all income-in-respect-of-a-decedent items in the estate, then allocate a share of that tax to the annuity income you reported that year.⁸ For joint and survivor annuities where the decedent died after payments began, the deduction is spread in equal amounts over the surviving annuitant’s remaining life expectancy.² Beneficiaries who miss this deduction pay tax twice on the same dollars.

State Estate and Inheritance Taxes

Federal rules are only half the picture. Some states impose their own estate taxes with exemption thresholds well below the federal $15 million. Others levy an inheritance tax, where the rate depends on your relationship to the deceased rather than the size of the estate. Spouses and children often pay little or nothing; more distant beneficiaries face higher rates. You can owe state tax on an inherited annuity even when the estate is far below the federal threshold, so the decedent’s state of residence needs a separate look.

Filing Form 706 for Larger Estates

For estates above the $15 million filing threshold, annuities are reported on Schedule I of Form 706. The schedule asks for a description of each annuity, its full value before exclusions, and the includible value at the date of death. If the executor elects the alternate valuation date (six months after death), that value goes in a separate column.⁹ The Schedule I value flows into the gross estate total on Form 706, and if the total gross estate minus allowable deductions exceeds the exemption, the graduated rate schedule applies to the excess.³

The estate tax return is due nine months after the date of death.¹⁰ An automatic six-month extension to file is available by submitting Form 4768 before the original due date, but the extension does not extend the time to pay.¹¹ Any expected tax should be estimated and paid by the nine-month mark; underpayment interest for the second quarter of 2026 runs at 6% annually, compounded daily.¹²

1
Internal Revenue Service. What’s New — Estate and Gift Tax
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Internal Revenue Service. Publication 575 – Pension and Annuity Income
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Office of the Law Revision Counsel. 26 USC 2001 – Imposition and Rate of Tax
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Internal Revenue Service. Estate Tax
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Office of the Law Revision Counsel. 26 USC 2039 – Annuities
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Internal Revenue Service. Section 7520 Interest Rates
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Internal Revenue Service. Actuarial Tables
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Office of the Law Revision Counsel. 26 USC 691 – Recipients of Income in Respect of Decedents
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Internal Revenue Service. Schedule I (Form 706) – Annuities
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Internal Revenue Service. Frequently Asked Questions on Estate Taxes
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Internal Revenue Service. About Form 4768, Application for Extension of Time To File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes
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Internal Revenue Service. Quarterly Interest Rates